Navigating NVIDIA's short-term volatility: using a protective collar options strategy

Investors holding NVIDIA shares might be worried: the stock price could stagnate or even drop, leading to potential losses. How can you mitigate these downside risks?

Today, I'll introduce a risk-hedging strategy using options: the Long Collar.

This strategy aims to cap your maximum losses while still allowing for potential profits if the stock continues to perform well.

The strategy mainly consists of three parts: "holding the underlying stock" + "buying a put option" + "selling a call option".

Holding the underlying stock and buying a put option forms a Protective Put.

This is equivalent to spending some money to buy "insurance". When the stock price drops significantly, you can exercise the put option to sell the underlying stock at the strike price, thereby limiting the risk of a price decline.

Holding the underlying stock and selling a call option forms a Covered Call.

Although your potential profit is capped if the stock price rises significantly because the call option buyer will exercise the option, you still gain the premium from selling the call option.

Combining "buying the underlying stock" + "buying a put option" + "selling a call option" together, we get Long Collar strategy.

In other words, under the premise of holding the stock, you use the proceeds from selling a call option to buy a put option as insurance.

While you give up some upside potential of the stock, you limit the downside risk. This is akin to placing a collar around the stock, locking in its returns, thus the name "Collar Strategy."

Some investors construct a combination where the premium received from selling the call option equals the cost of buying the put option, making the cost of limiting losses completely offset by the income from selling the call option. This is called a Zero-Cost Collar Strategy.

When not holding the underlying stock, you can click Strategy > choose Collar to buy the underlying stock, buy a Put and sell a Call in one go.

When holding the underlying stock, you can Strategy > choose Single Option to separately sell a Call and buy a Put.

The specific choice depends on your own decision.

Suppose you hold 100 shares of NVIDIA (NVDA), currently priced at $124.30 after Monday's close. You don't want to sell your shares now, but you also want to protect against further downside risk. In this scenario, the Long Collar strategy can be useful.

First, you sell an NVDA Call option with a strike price of $130 and an expiration date of July 5 at a price of $0.41 per share.

Second, you buy an NVDA Put option with a strike price of $118.5 and the same expiration date of July 5 at the same price of $0.41 per share.

In this process, the income and expenditure of the two options offset each other, allowing you to construct a Long Collar without paying a premium.

When using this strategy, you should bear in mind that it may not be applicable to all underlying assets and any investment involves risks.

Involving a long put and a short call, the long collar strategy is used to guard against downside risks for a long-term bullish stock. Hence, your selection of the expiration date is highly relevant to your expectation of how long uncertainties will last.

The general market experience is:

If you expect the stock to fall in the short term, you may choose a closer expiration date.

If you expect long-lasting fluctuations, longer-term options might be more suitable.

When setting up this strategy, you may adjust the price spread between the call and the put to the current stock price to meet your needs and risk tolerance.

A Long Collar still has the potential for loss; the strike price can be adjusted according to risk tolerance. The general market experience is:

Short Call: You may set the strike price close to an acceptable take-profit price.

Long Put: You may set the strike price based on your expected stop-loss price.

As the buyer of a Put option, if the option is in-the-money at expiration, the system will automatically exercise it.

Automatic exercise conditions: For U.S. stock options, the options are in-the-money by as little as $0.01 at expiration at market close of the expiration date.

The exercise will be completed through physical delivery. Since you hold the underlying stock when constructing the Collar strategy, the system will automatically sell the stock at the Put's strike price.

If you do not wish to sell the stock using the Put, you can choose "Lapse Exercise". In this case, even if the option is in-the-money, the system will not automatically exercise it, and you will not receive any exercise profit.

If you hold American-style options, you can also choose "Early Exercise" before expiration, but this may result in the loss of the option's time value. Therefore, it is generally not recommended to choose early exercise under normal circumstances.

As the seller of a Call option, if the buyer chooses to exercise, you may be assigned to sell the stock by the clearinghouse.

The exercise will be completed through physical delivery. Since you hold the underlying stock when constructing the Collar option combination, the system will automatically sell the stock at the Call's strike price during the settlement.

If you do not hold the underlying stock at the time of assignment, the system will automatically use the cash/margin in your account to buy the stock for delivery. If the cash/margin is insufficient, the system will automatically liquidate other assets in your account to fulfill the exercise settlement, which may cause unnecessary losses. Therefore, it is recommended that you constantly monitor your account status and ensure sufficient cash/margin is available.

Alright, that wraps up today's sharing.

The strategy shared above is mainly applicable for hedging the risk of a decline in Nvidia's stock price.

If your expectations for future stock price movements become clearer, you can close the position of Long Collar and engage in directional trading, such as Call or Put options, based on subsequent market conditions.

If you have other ideas about Collar Strategy, feel free to share and discuss them in the comments section.